a. Does Smiths approach to calculating customer profitability have a bias that tends to make customers like
Question:
a. Does Smith’s approach to calculating customer profitability have a bias that tends to make customers like Houston appear unprofitable?
b. What would have been the impact on income before taxes to Turner in 2021, if there had been no sales to Houston Memorial? Note that answering this question will require that you make one or more reasonable assumptions which you should state in your answer.
c. Do you think it is wise for Turner to “fire” the 10 hospitals that do not appear to be profitable? Explain.
Turner Hospital Supply provides equipment and products related to hospital care. Examples include blood pressure monitoring devices, devices for delivering anesthesia, instrument stands, exam stools, gloves, bandages, and surgical masks. In all, the company sells more than 1,000 SKUs (stock keeping units). For the year ended, December 31, 2021, income before taxes was $6,000,000.
At a recent conference, Ronald Smith, VP of Finance attended a seminar on customer profitability. He returned to his job determined to calculate customer profitability for each of the 250 hospitals that buy from Turner.
To do so, he had his accounting and IT staff trace sales and cost of sales to each customer. This was relatively easy. But how should the company assign selling and administrative costs (e.g., delivery, billing, material ordering, depreciation, and salaries) to customers? To simplify, Ronald observed that selling and administrative costs amounted to 40% of sales in 2021. Thus, he used 40% of sales as a measure of selling and administrative expense applicable to each customer. He then observed that only 10 hospitals were not profitable. He immediately called a meeting of the company’s senior executives, presented his data and suggested that these customers should be dropped.
his shocked Mary Wexler, the Senior Vice President (SVP) of sales, as seven of the companies were large customers. In fact, while average sales per hospital were $480,000, these seven hospitals had average sales over $800,000 per year. One of the hospitals was Houston Memorial Hospital. The calculation for this hospital indicated that Turner lost $90,000 on Houston Memorial in 2021.
Sales......................................................$ 1,100,000
Cost of sales...............................................750,000
Gross margin.............................................350,000
Selling and administrative expense........440,000
Income before taxes.............................$ (90,000)
Mary knows that most of the sales to Houston were pieces of equipment such as defibrillators, patient monitors, surgical tables and surgical lights. These items have lower margins (around 30% of sales) than disposable products like gloves, bandages, and surgical masks (around 50% of sales), but the low margins are applied to much higher prices.
Mary asked for a couple of days to consider next steps and the group agreed to take the matter up at another meeting early next week.
Step by Step Answer:
a Yes Smiths approach to calculating customer profitability has a bias that tends to make customers ...View the full answer
